A China crisis or just a year end credit crunch?

Today my intention is to peer under the bonnet of the Chinese economy where there are currently signs of some distress in the monetary system. If nothing else the way that this has recently started makes me wonder if the start of the taper- a reduction in monthly QE purchases by the US Federal Reserve- is already having a effect. Earlier this year a combination of expectations and rumours of such a taper caused economic problems in emerging markets from India to Indonesia. Actually according to Bloomberg a rather similar effect was seen on Indonesia at the end of last week.

Indonesia ‘s rupiah fell to a five-year low

In round numbers, the Rupiah has fallen by just over 20% since taper thoughts began in May. Of course we are in another period of expectation as the recently announced tapering does not actually commence until January.

China’s monetary system

The post taper announcement has coincided with something of a credit squeeze in China’s monetary system. This is having an effect which will put those with memories of how the western credit crunch began on alert. From the New York Times today.

One key rate, the seven-day repurchase rate, rose as high as 10 percent on Monday. That was double the rate of a week earlier and the highest level since June,

This interest-rate closed at 8.94% today which in itself is food for thought in an era of -for some anyway- of ZIRP or zero interest rate (policy). If we look back the acceleration higher began on the 16th of this month when this interest-rate moved towards 4.5%. So it did begin before the taper announcement but much of the acceleration has come after it.

Another possibility is that this is simply a type of year end squeeze but if we look back to last year we see that the seven-day repurchase rate only reached 4.6% so something is different this time around.

What is the People’s Bank of China doing?

It has responded in this way according to Bloomberg.

The monetary authority is instead tackling the cash crunch using short-term liquidity operations that supply funds to unnamed banks and said Dec. 20 more than 300 billion yuan ($49 billion) was added in three days.

So the People’s Bank of China is responding to the situation albeit with little effect so far although it may well be doing so with rather a red embarrassed face. The PBOC has been squeezing the Chinese monetary system as it attempts to deal with something of a shadow banking boom. An expanding shadow banking system was also a feature of the run-up into the western credit crunch. I pointed this out back on the 24th of June when the Chinese monetary system was also exhibiting signs of strain.

A fundamental issue here is exactly how one safely deflates a boom driven by a shadow banking system as using interest-rates to do so has so far not worked. Rather than letting air gently out of the ball such moves have invariably clattered us straight from boom to bust. So if the PBOC does succeed here it will have succeeded where others have failed.

Of course the Chinese command economy may yet succeed where us western capitalist imperialists failed but only six months later there are signs of trouble again. So far this episode has not seen the 11%+ peak for the seven-day repurchase rate of the June episode but fears are rising of this being a repeating cycle. If we look back the western monetary system flashed warning signs for quite some time before toppling over.

The official response as highlighted by this below from the Shanghai Securities News via Google Translate is ‘move on there is nothing to see here’.

In short, with the experience of June this year, the market do not have too much to worry about.

Once reassurance is issued then step two is to blame speculators.

the market produced a panic psychology, there may even be some speculators take advantage of these factors to further create tension profit from.

China’s economy

If we move from the monetary system to the real economy we see this. Economic growth in the third quarter of 2013 was 7.8% which for China means that so far in 2013 each quarter has seen growth of less than 8% and hence an overall slow down. Of course the majority of countries would love such a growth rate but the unbalanced nature of Chinese growth has led to fears of it making the western error and entering a boom and bust phase.

There is also the issue of how accurate this data is which has been reinforced recently as yet another area of China has admitted to falsifying the numbers. Of course we in the west need to be careful about throwing stones from the equivalent of a glass house but China’s economic growth could easily be a couple of per cent lower than the boasts of official communiques.

However the business surveys are optimistic

The HSBC Composite Output Index signalled the strongest increase of business activity in eight months, posting up from 51.8 in October to 52.3 in November. Manufacturers reported increased production for the fourth month in a row in November, and at the strongest pace since March. Service providers also signalled an expansion of business activity in November.

Although manufacturing did experience something of a slow down in December.

Flash China Manufacturing PMI at 50.5 in December (50.8 in November). Three-month low.

Comment

If we examine the Chinese economy we see one which on the surface appears to have been barely affected by the credit crunch. It is easy to make a case for the blue pill of the film Matrix when an economy considers a growth rate of over 7% as poor when other countries have struggled to grow at all. At a time when western economies are in the consumption orgy that is a modern Christmas it is revealing to note that the latest retail sales numbers in China show growth of 11.8% on a year before.

Yet on the other side of the coin the western economies hit an iceberg in the manner of the ship the Titanic which is that so many were predicting and projecting ”full steam ahead” until the crunch and thump of the strike itself. It is easy to dismiss the current monetary problems in China and say that (so far at least) they are relatively minor if compared to the summer. However to my mind the correct thought is that these are beginning to occur on a much more frequent basis and that this the problem. It only takes one word to ask the question why?

When one does so it becomes clear that the People’s Bank of China has a difficult job and that like a fly in a spider’s web there may be no easy way out if there is one at all.

At the same time I note that the Chinese authorities have over the past week or two been giving Bitcoin something of a pasting. Is its current problem a consequence of that? Are virtual currencies now of consequence? Probably not yet, but I suspect that the two events are likely to be related. It was put to me the other day that Bitcoin was a way that the Chinese middle class could pass their money to outside China’s borders well until this it was anyway. From BTC China on Friday.

Due to regulatory uncertainties this past week, many third-party payment-processing companies have suspended their business with Bitcoin exchanges in China. We were also affected, and BTC China is now temporarily unable to process CNY deposits.

With a little help from my friends

I was thinking that we would be borrowing from the Chinese but you never know especially in the credit crunch era. From last June.

Governor Zhou Xiaochuan and Governor Mervyn King have signed an agreement to establish a reciprocal 3‑year, sterling/renminbi (RMB) currency swap line. The maximum value of the swap is RMB 200bn. The swap line may be used to promote bilateral trade between the two countries and to support domestic financial stability should market conditions warrant.

Hi Shaun I thank you for all the hard work you have done this year so as people like myself can understand what truly is going on in the financial world.May I wish you and all of those who post comments to make this blog a must read all the very best for Christmas and the new year.

Anonymous

Hi Shaun
I presume that this will be continuing whilst much of the western world stops for Christmas? I hope that by the time we fully return in the new year that things have stabilised in China. However I do take your point that such events point to underlying issues and trouble there.

therrawbuzzin

I’d very much like to echo that.
Merry Christmas to you and yours Shaun, and a happy and healthy, peaceful and prosperous New Year, to all at MM, and those whose posts often add to the illumination.

Anonymous

Hi Midge

Thank you and Merry Christmas and a Happy New Year to you too

Anonymous

Hi therrawbuzzin

A very Merry Christmas and Happy New Year to you as well.

Anonymous

Hi Josephine

I expect more action from the People’s Bank of China tomorrow if things remain the same so we may not even have to wait until Christmas for the next installment.

Rods

Hi Shaun,

Thank for all of your hard work for the last year, especially in shining your spotlight and illuminating some very dark financial corners.

Wishing you and your family a very happy Christmas.

Anonymous

Thank you Rods and Merry Christmas to you and your family too.

Paul C

Shaun,
May I extend my best wishes to you and your family at this festive time. Your blog stands out as an impartial examination of the economic circumstances of the time, long may it continue.
On the subject of China, it is an alien culture to the western “democracies”. I was there on business for 3-weeks in the spring and enjoy wide advice. They definately have problems with money but it is really difficult to apply western templates because many of the cultural differences & relative unsophitication make for often opposite outcomes.
We need to follow closely their market liberalisation of financial matters because if it goes wrong there will be catastrophe. Here are some of the wierd & unique circumstances.
1) The demographics, billions in an inverted pyramid, where parents and grandparents pressure success and money downwards to a minority of offspring. Homes for young people are often financed by old people whereas in Britain old people “tax” young people in rent.
2) Unsophisticated capitalism, gambling addiction, get rich quick, naiivety and belief in luck. You can’t put your finger on any one trait but no long term reliable investments are available. The folk are savvy and hard-working but there is no savings account delivering 5% interest despite the banking squeeze and elevated rates. They do love the 6 number or the 13 number, they all know someone who got rich quick but don’t really understand how, only that it could be them next! Their stock markets are fluctation riddled through lack of trust worthy investments and herd insecurities.
3) Property has been proven to be a winner in the main cities, why whould you save in a ZIRP bank account when property could get you 20% although much is sold off plan rather than built. Further extenuating the high risk and entrepreneurial carry-on. Properties built off plan are often sold at 1st fix stage further complicating the investment profile with owners completing to their own specification – so what did it cost?
4) Local Govt.s “print money” by selling land, they are and have been a major shadow-banking system. How can the PBOC squeeze credit supply when there are complicit developers handing over millions to corrupt officials enabled by local development banks.
5) Large businesses are incentivised to re-locate for cash, to bring employment and tax revenue to major centres. White elephant projects promote the “ambition and profile” of a destination which is why you see bizarre over-building. The same money is used to subsidize and retain failing businesses where there is an employment revenue kick-back. So is the apparently large and successful conglomerate actually successful?
6) Businesses in China have grown organically through re-investment of profits for growth. The banks have no history of venture or long-term lending without asset backing. There is no lending facility except for businesses with strong asset profiles. Cash is king in business, cash is how they have succeeded, cash is a powerful negotiator and a strong influencer that does not come with the pain of paperwork or legal professionalism.
7) The Generational divide is mind-boggling. You see 17 year-olds obsessed with their phablets on the subway commuting to do a software job in the city whilst outside the train station illiterate 50-year olds are manually-fashioning “sweet sticks” from pineapples. They are both working for a living and sharing the “success” of their nation.
I reckon there’s more that I could write but hopefully you get the idea, that you cannot apply western thinking or logic to understand the country.
Merry Christmas all

Shaun Richards is an independent economist who studied originally at the LSE. His speciality is monetary economics and he uses it to analyse current economic trends. He started his career in the City of London in 1985 and brings his trading experience in bond, currency and derivative markets to his analysis of current economic events. Follow him on twitter @notayesmansecon.